Start with the assumption that you will need to replace about 85 percent of your pre-retirement income from a combination of savings and Social Security. If you expect income from other sources — perhaps a pension or part-time work — or if you plan to pay off your mortgage before retirement, your replacement target may be lower. Next, divide the amount you have already saved for retirement by the current income from your job. If you earn $50,000 per year, for example, and you have saved $100,000 so far, your retirement savings-to-salary ratio is 2. If you’re 40 years old, congratulations, you’re on track for a secure retirement — assuming that your wages will grow by 4 percent per year (meaning your contributions would increase along with your salary) and Social Security will replace about 40 percent of your earnings.
But if you’re 45 or older, you’ve got some catching up to do. Ideally, if you plan to retire at 65, your combined savings and investment earnings should equal more than ten times your final salary. And higher-wage earners should be aware that Social Security will replace a smaller portion of their pre-retirement income.
If your account balance isn’t what it should be, it’s time to make some changes. Focus on the three factors you can control: how much you save, how long you work and how much money you spend in retirement.
Younger workers have the most to gain from increased savings because they have more years for those savings to accumulate and for compound interest to work its magic. And because your 401(k) contributions escape federal and state income taxes (but not FICA taxes), the pain in your paycheck may not be as bad as you fear.
Many workers fail to contribute enough to their retirement plans to capture the full employer matching contribution. Nearly 90 percent of respondents in a recent survey admitted that they could save more. So, where do you find room in your budget to increase your savings? Consider cutting back on some luxuries, such as a daily latte or a pricey car, to fund a more comfortable retirement. A 30-year-old who saved an extra $70 per month would add more than $160,000 to his nest egg in 35 years, assuming an average investment return of 8 percent per year.
Investors in their late fifties who are behind in their savings may find that increasing the amount of money they sock away is not enough. But other changes — such as delaying retirement and reducing expectations of how much you can afford to spend when you get there — have a greater potential impact.
(Mary Beth Franklin is a senior editor at Kiplinger’s Personal Finance magazine. Send your questions and comments to [email protected]. And for more on this and similar money topics, visit Kiplinger.com.)
